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THE DIFFERENCE BETWEEN THEN AND NOW

It was a glorious time. The Red Sox and Yankees were both on their way to the playoffs and the New York football Giants had just wrapped up the preseason before their Super Bowl season. Jets fans still had a clean slate in front of them and oh yeah, the stock market was on an upward trajectory toward the October 2007 high. August 2007 was also the last month the riverboat gaming markets generated positive same store sales.

I use win per day per gaming position (WPD) as a proxy for same store gaming sales as shown on a trailing twelve month basis in the chart. We’ve now had 12 straight months of declines in WPD and 19 out of the last 20. Ouch. As bad as that looks, it was even uglier in 1. WPD declined 13 straight months, averaging 17% down per month. Now that was pain.

Regional gaming stocks got crushed beginning in mid-1996. It’s probably no coincidence that my first day covering the gaming sector was also in mid-1996. Maybe that’s why I’ve always been good on the short side. But stocks rebounded strongly beginning in late 1998 and lasting a decade, interrupted only by 9/11.

So why shouldn’t we be loading up on regional gamers? Valuations are 5-6x, in-line with those prevailing in the mid to late 1990s and WPD trends are similar if not better. Let’s go to the video tape, actually the chart, to answer this question. The difference between now and then is that while WPD declined in 1, total revenues increased dramatically. Markets were still growing. The pie was getting bigger. New casinos were just cutting the slices smaller, temporarily. Fast forward to present time and we see that the markets are contracting along with WPD. Gaming is cyclical after all.

Unlike the late 90s, the market is not growing

JBX – SIGNIFICANTLY UNDERVALUED?

I woke up this morning to read that Western Sizzlin (WEST) is going to commence an exchange offer for up to 680,500 shares of JBX. The offer values JBX at $22.66. For reference the market capitalization of WEST is $38 million and JBX is $1.1 billion. If all the shares are tendered it would represent only about 1% of the outstanding shares of JBX.

The CEO and controlling shareholder of WEST is Sardar Biglari. Mr. Biglari holds a 35% interest in WEST through The Lion Fund L.P., a private investment partnership. Mr. Biglari is the general partner of The Lion Fund L.P., which is an activist hedge fund. WEST and The Lion Fund have bought positions in a several public restaurant companies that were perceived to be value plays. In the past, Mr. Biglari has been very public about putting pressure on senior management of these public companies to unlock shareholder value. Until WEST files its S-4, Mr. Biglari’s intentions are unknown.

JBX’s management is one of the more impressive management teams in the restaurant industry. That is not to say that they are managing the business perfectly and that there are no levers to pull that could create shareholder value, but in this environment not much is going to get done. JBX is clearly a value stock trading at 5.0x NTM EV/EBITDA.

So what could Mr. Biglari be thinking?

First, JBX operates and franchises Jack in the Box restaurants and Qdoba Mexican Grill. In the past, many have speculated that the company should spin-off Qdoba to create vales for shareholders. I am not sure how that scenario would work in this environment. The company also operates more than 60 proprietary convenience stores called Quick Stuff®, which include branded fuel stations. While the Quick Stuff’s are developed adjacent to a full-size Jack in the Box restaurant, it is not a core competency of the company. This would be a clear target for any investor looking to sell off non-core assets.

US Market "Trade" Getting Bullish Down Here...

I just started covering and buying. I have a downside support level in the S&P500 of 1030.93 (see ‘Hedgeye Portfolio’ for security specific moves).

After patiently sitting on a 96% Cash position since the initial Paulson ‘bail out my friends’ announcement, I have moved to 93% Cash this morning.

Treading into the water, slowly.
KM

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.63%

"Trend" negative: Obama extends his lead...

As we review the polls and political futures markets from this past weekend, Obama seems to be expanding his lead.

Despite Governor Palin’s “better than expected” performance in the Vice Presidential debates last week, McCain has received no bounce. The current Real Clear Politics national poll average shows Obama up +5.9 and Intrade Market show a 65.5% chance of an Obama victory. In addition, on an electoral college basis Real Clear Politics has Obama up by an astounding 168 electoral college votes.

We have been writing since August that an Obama victory is likely and that his victory will be negative for the equity markets in the intermediate term. As a result, we have been positioned very conservatively (96% Cash, 3% Gold) and will be positioned conservatively from here through November 4th subject to the facts changing.

Daryl Jones
Managing Director

PNRA – Wheat Price Favorability

Wheat prices declined nearly 14% last week and are down 50% from the peak levels seen back in March. For PNRA, a $1 change in the price of wheat impacts the company’s full-year costs by $3.25 million, or about $0.06 per share. PNRA offsets some of these rising costs with price increases, however, so the company does not typically feel the full impact of that increase on the bottom line. Earlier in the year, PNRA locked in its full-year 2008 wheat costs at $14/bushel and has since then contracted 95% of its 1H09 requirements at $10/bushel (versus the average $15/bushel paid by the company in 1H08). Based on the 1H09 cost of $10/bushel, the $4 of wheat price favorability versus 2008 represents about $13 million of lower commodity costs in FY09.
  • With wheat prices having recently fallen to below $7/bushel, PNRA could see even more substantial savings in the back half of 2009. Management said back in June when it announced that it had locked in its wheat requirements for 1H09 that part of the benefit from more favorable YOY wheat costs would be offset by higher commodity costs, notably proteins, dairy, packaging, and the increasing cost of gasoline, but that was when wheat was trading closer to $9/bushel.
  • Also, PNRA has not seen the demand destruction experienced by other restaurant companies. The Panera Bread concept is able to attract customers at multiple day parts, which is a clear advantage in difficult times. Helping to drive sales is a new breakfast sandwich which is driving incremental customers in the critical morning meal period. If top-line trends continue to hold up in FY09, I would expect PNRA to see incremental benefit to its bottom line as the company finally experiences some relief on the wheat cost front.

Wearing New Shoes

Stocks, commodities, real estate, and foreign currencies are all crashing again this morning. No, they aren’t going down – they are crashing. Whether it’s the Russian stock market trading down -13% or the South Korean Won moving to -27% for the year to date, it’s all one and the same in this complex global economic system of macro factors. It is global this time, indeed. Cash remains king.

By month’s end, it will have been 1 year since I left Carlyle’s hedge fund. Time flies when you’re having fun.

October 2007 was the last month that I worked in New York City for someone else. On the day of my departure, I walked down 5th Avenue and bought a new pair of shoes. My son was due to be born in the coming week and it was time to start my new life. My days of trading a “book” for a hedge fund were over. I left my old shoes in their office to symbolize as much. My last “call” on the global market, and the industry in general, has turned out to be right.

Leaving any firm in NYC can be very impersonal. You take the elevator downstairs, open the door to New York’s finest taxi cabs honking at one another and that’s your goodbye. As I walked to Grand Central Station that night, I said to myself, goodbye and good luck.

My last month of trading on Wall Street was a profitable one. It was October, and my shorts had already started working. It’s no secret that I had an unprofitable Q3 of 2007. I’d had a huge run in the 8 years prior, and my short term luck had run its course. You can ask my team about it – my best analysts from Carlyle now work at SAC and Ziff. I had no excuses. I was a few months too early. I was too bearish to earn a myopic weekly return. That down quarter was all my fault, no one else’s.

The good news for me is that I haven’t had many “bad quarters” and that one in particular was only down low single digits. At the time, I was told that I was being “too macro”, and I suppose that was a sign of the global market top in and of itself. That’s not telling you much other than what it is that people say about me when I am not in the room. It is what it is. Numbers don’t lie, people do.

Since late 2007, many of you have seen every “Trade” and every “Trend” that I have “called” and acted on. Transparency and accountability were the principles I cared to espouse, so that’s what I set out to do. I started ranting on my ‘MCM Macro’ blog (www.mcmmacro.blogspot.com) in Q4 of 2007, and those views are still open to the public to audit. On Tuesday April 1, 2008, I submitted a performance report for MCM of +2.15% (the S&P 500 was -10% and the NASDAQ -14%), and my new Partners and I proceeded to open the doors of Research Edge LLC’s office in New Haven, CT. Since November of 2007, my portfolio has made money every quarter. Well ahead of last week, I had been calling for a market crash. Last week, the S&P500 was down -9.4%, and I was +0.28%.

Unfortunately, this business pays a higher multiple for accuracy than it does principles. We’re seeing the ugly side of that “Trend” now. It was unsustainable. Now it’s time to re-build the trust in client relationships that Wall Street lost. Work ethic and handshakes are important to us. We think they are to other people too.

This morning is the last “Early Look” that we will be issuing to Institutional Research Edge subscribers for free. Our Hedgeye subscribers will continue to get the “Early Look” note via email. Feel free to pass this along to your friends (they can sign up at www.hedgeye.com). We feel an obligation to help you protect and preserve your family’s hard earned capital during times like these. We are here for you, feet on the floor, bright and early every morning.

For our Research Edge Institutional clients, we are launching ‘Research Edge Macro’ tomorrow. Having never been a “scribe”, and needing to earn my stripes every day, I felt that the right thing to do was work for the market for 2 quarters for free. While I still do not plan on paying myself any time soon, I do feel that our paying clients are due the exclusivity of our service. We have 20 people working on our team now. We are hiring. This isn’t about me. This about my team being better than I could ever be on my own.

In two short quarters, we have already broken through the 100 Institutional client milestone, and we have visibility on getting to 200 in the coming months. Most of our clients have given us praise for “being right” year to date, and for that I am very humbled and grateful. Getting a thank you in this business is a wonderful feeling.

So let me take this opportunity to thank all of you. Most importantly, thank you to all of you who believed in us, and are so kind as to cross pollinate your research edge with ours. Without having the opportunity to work for you, we couldn’t be wearing these new shoes with so much pride.

The best way to predict our future together is to create it. We’re looking forward to the journey,

Keith R. McCullough




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